Alan Greenspan and the Financial Crisis

Alan Greenspan has taken a lot of flak for his policies on reduced regulation and low interest rates during his tenure as the Chairman of the Federal Reserve.  In particular they are blaming policies that were enacted under his tenure for directly causing the financial crisis.  I personally think he did a pretty good job (although I’m no economist).  The media and the general population are usually looking for specific people to blame and they’ll usually target the most visible people (as opposed to some more complex interweaving of decisions and policies that accumulated over time).  I think Alan Greenspan has been unfairly portrayed in the media as someone who made a wrong decision that led directly to the financial crisis.

The main reason for this opinion is that I asked myself the same kind of question you’re supposed to ask when deciding if you played a hand well in poker: given the information that he had, did he make a good decision?  I think he did.  Most people seem to be forgetting the idiom: hindsight is 20/20.  Very few things were obvious at the time.  Was it obvious lowering the interest rates in 2002 would cause a financial crisis in 2008?  No.  Was it obvious that several incidents of unfair lending practices for subprime mortgages would result in a widespread systematic problem?  No.  Was it obvious that well respected financial institutions packaging up these complex products would completely ignore the obvious signs that most of the subprime loans could not be repaid?  No.  None of these things were obvious.  Sure some experts predicted them, but then again some experts had predicted that everything was going well — both with their own set of data and statistics.  So who are we to believe?  It’s not so obvious.

I don’t think any one can argue against the fact that Alan Greenspan is a very intelligent fellow.  Most articles I’ve read about his testimony focus on the fact that he did not admit to causing the financial crisis — not the important stuff he has to say.  When smart people talk, I like to listen — instead of getting it filtered through some news site.  So regardless of your opinion of his decisions, I think it’s important to hear what he has to say, instead of a summary by a 24-hour news source.  Here’s a portion of his testimony that just makes a lot of sense to me (and the link to the transcript).

“We can legislate prohibitions on the kinds of securitized assets that aggravated the current crisis. But investors have shown no inclination to continue investing in much of the past decade’s faulty financial innovations, and are unlikely to invest in them in the future. The next pending crisis will no doubt exhibit a plethora of new assets which have unintended toxic characteristics, which no one has heard of before, and which no one can forecast today. But if capital and collateral are adequate, and enforcement against misrepresentation and fraud is enhanced, losses will be restricted to equity shareholders who seek abnormal returns, but in the process expose themselves to abnormal losses. Tax payers will not be at risk. Financial institutions will no longer be capable of privatizing profit and socializing losses.”
Alan Greenspan, Testimony to Congress on Financial Crisis